January 30, 1998

Using IRA for down payment not a good idea

By TOM KELLY
The Real Estate Advisor

The ability to tap Individual Retirement Accounts for the down payment for a home may sound terrific, but how just how many first- time buyers will realistically use this new option?

A provision in the 1997 Taxpayer Relief Act allows penalty-free withdrawals of up to $10,000 for the down payment and closing costs of a home. As of January 1, 1998, withdrawals can be made from established IRAs of spouses, parents, children, grandchildren or ancestors as long as they total no more than $10,000.

Lawmakers said that this move would help "tens of thousands" of Americans overcome the single-biggest barrier to home ownership -the lack of sufficient cash for closing.

"I'd advise people only to use the IRA as the last resort for buying a home," said Conrad Gehrmann, real estate tax specialist in the Seattle accounting office of Arthur Anderson. "I would leave that IRA alone at all costs. If you can borrow the money for the house from Uncle Joe or a good friend, it would probably be the better way to go."

Gehrmann, and other tax people, know that owning a home is also a "forced savings plan." The money that you put in to home ownership is usually returned - with appreciation - when it's time to sell. Sometimes the appreciation can offset the amount of interest the borrower has paid on the home loan.

"What you would really like to see is people with an individual retirement account plus a home," Gehrmann said. "That way, they will have two very good sources to look to when they no longer are working."

Gehrmann is right. That's the reason for the "R" in IRA. If the account were to used during our working years, the "R" would have been substituted for a "W".

I expect lenders to sharpen their pencils and in an effort to corral both IRA and home-loan customers. The competition for consumer dollars is intense, and those lenders who can produce a workable, creative niche often soar above their rivals.

Ten years ago, Kirk Schuster, a veteran Puget-Sound area mortgage broker, dreamed up an IRA-based home-loan program designed.

However, changes to an affordable-housing bill were not signed, and his program, which featured loans at a full percentage point below market rates, never got off the ground.

The problems arrived when the fine-print IRA rules were scrutinized. Bankers were not supposed to give consumers anything of value to attract customers.

The basic idea was similar to several "pledged asset loans" that are on the market today. The idea is to keep an asset intact while using it as collateral for a loan. For example, if a parent moves his retirement savings in the form of a certificate of deposit to lender participating in a pledged asset loan, the funds are eligible to be counted as the down payment for any family member.

The funds continue to draw interest. When the value of the home exceeds the original appraised value, the CD is released. If you do want to use your - or someone else's - IRA funds for the down payment of a house, Gehrmann cautions that they money will still be subject to normal income tax - there simply is no 10 percent, early withdrawal penalty.

Misinformation given by local Internal Revenue Service offices has added to the confusion. According to a recent federal tax-court case, a couple was charged for withdrawing their IRAs to buy a home even though their local IRS public-assistance representative said the funds would not be taxable.

Emma and James Clarke each withdrew $16,000 from their IRAs. They wanted to be certain the amounts were not taxable because the Clarkes said they would not be able to purchase the house and pay taxes on the $32,000 withdrawal. According to the Clarkes, they were told no penalty would be assessed.

The court ruled that when IRS employees give incorrect interpretations of the law, the IRS is not bound by that advice.

In fact, the IRS is not generally bound by the language of its own publications. The court ruled the Clarkes' withdrawals were taxable under the rules that generally apply to IRA distributions.

If you are able, obtain the down payment for a home from Uncle Joe. Or, perhaps your boss will come through with that no-interest loan she's been talking about for years. Do your best to keep the "R" in Individual Retirement Account.

Previous columns:

• The lowest interest rates not always best, 01-23-1998
• Getting money back from FHA, 01-09-1998
• Big tax cuts coming to real estate, 12-12-1997
• Will better trained salespeople increase minority homeowners?, 12-05-1997
• Home loan rates will remain flat, 11-27-1997
• Boeing, CB-Bain sign affinity marketing deal, 11-21-1997
• Home-equity: Should you bet the roof?, 11-07-1997
• Builder sweetens Costco dealer for agents, 10-31-1997